Mortgages in plain terms

A lender is deciding two things and only two things. Can this household afford the payments, now and if conditions worsen? And if it stops paying, can the loan be recovered from the property? Everything a lender asks for is aimed at one of those questions, and knowing which makes the process far less opaque. Bank statements, employment evidence and outgoings serve the first. The valuation serves the second.

Loan to value

The loan expressed as a proportion of the property's value is the number that most affects what a borrower is offered. A larger deposit reduces the lender's exposure, and lenders price that in steps rather than smoothly: crossing a threshold changes the products available. Borrowers close to a threshold are often better served by finding the small additional sum than by any amount of shopping around, because the step is worth more than the spread between lenders within a band.

Term, and what it really trades

The term is how long the loan is scheduled to run. A longer term lowers each monthly payment and raises the total interest paid over the life of the loan, because the balance falls more slowly. A shorter term does the reverse. This is a genuine trade rather than a right answer: a longer term buys monthly headroom and costs more overall; a shorter one costs more monthly and less in total.

The related point is that the arithmetic is front-loaded. In the early years of a repayment loan, most of each payment is interest and the balance barely moves; by the late years the proportions have reversed. People are frequently surprised by how little the balance has fallen after five years. That is not a defect in the product; it is what amortisation looks like.

Repayment against interest only

On a repayment basis, each payment covers the interest and takes a slice off the balance, so the debt is gone at the end of the term. On an interest-only basis, payments cover the interest alone and the full balance remains outstanding at the end, to be repaid some other way. Interest-only is much less common for owner-occupied purchases than it once was, and where it is available lenders require a credible plan for repaying the capital. The monthly saving is real and the obligation does not go away.

Fixed and variable

A fixed rate holds the interest rate for a stated period, commonly a few years, after which the loan reverts to the lender's standard variable rate unless a new deal is arranged. A tracker follows a published reference rate with a margin. A standard variable rate moves at the lender's discretion. The choice between them is a choice about certainty rather than about cost: a fix buys a known payment for a known period, at whatever price the market puts on that certainty at the time.

Two practical consequences follow. First, fixed deals almost always carry early repayment charges, so the length of the fix should match how long you expect to keep the loan unchanged. Second, the end of a fixed period is a date to diarise, because reverting to a standard variable rate by inattention is one of the more expensive forms of forgetting.

Affordability and stress testing

Lenders do not simply check that a household can meet today's payment. They test whether it could still meet payments at a materially higher rate, and they read committed outgoings — other credit, childcare, dependants — against income. This is why two households with the same income can be offered noticeably different amounts, and why a modest change in regular commitments can change what is available.

A decision in principle is an early indicative view based on information you have supplied, and it is useful mainly as evidence to a seller that you are a serious buyer. It is not an offer. The formal offer comes after full underwriting and the lender's valuation, and it can differ from the indication, particularly if the valuation comes in below the agreed price.

Fees, and the total cost of a deal

Products carry arrangement fees, valuation fees and sometimes broker fees, and a lower headline rate with a large fee can cost more over a short fixed period than a higher rate with none. The honest comparison is the total paid over the period you will actually hold the product, including fees and including whether the fee is paid up front or added to the loan — where, quietly, it accrues interest for the rest of the term.

This guide explains mechanics only. Which product suits a particular household depends on facts about that household, and that is a conversation for a qualified adviser rather than for a page on a website.